Home Insurers’ Secret Tactics Cheat Fire Victims, Hike Profits

By David Dietz and Darrell Preston, Bloomberg.com

Aug. 3 (Bloomberg) — Julie Tunnell remembers standing in her debris-strewn driveway when the tall man in blue jeans approached. Her northern San Diego tudor-style home had been incinerated a week earlier in the largest wildfire in California history. The blaze in October and November 2003 swept across an area 19 times the size of Manhattan, destroying 2,232 homes and killing 15 people.

Now came another blow. A representative of State Farm Mutual Automobile Insurance Co., the largest home insurer in the U.S., came to the charred remnants of Tunnell’s home to tell her the company would pay just $220,000 of the estimated $306,000 cost of rebuilding the house.

Tunnell joined thousands of people in the U.S. who already knew a secret about the insurance industry: When there’s a disaster, the companies homeowners count on to protect them from financial ruin routinely pay less than what policies promise.

Insurers often pay 30-60 percent of the cost of rebuilding a damaged home — even when carriers assure homeowners they’re fully covered, thousands of complaints with state insurance departments and civil court cases show. Paying out less to victims of catastrophes has helped produce record profits. In the past 12 years, insurance company net income has soared — even in the wake of Hurricane Katrina, the worst natural disaster in U.S. history.

Property insurers systematically deny and reduce their policyholders’ claims, according to court records in California, Florida, Illinois, Mississippi, New Hampshire and Tennessee.

The insurance companies routinely refuse to pay market prices for homes and replacement contents, they use computer programs to cut payouts, they change policy coverage with no clear explanation, they ignore or alter engineering reports, and they sometimes ask their adjusters to lie to customers, court records and interviews with former employees and state regulators show.

As Mississippi Republican U.S. Senator Trent Lott and thousands of other homeowners have found, insurers make low offers — or refuse to pay at all — and then dare people to fight back.

“Money managers have taken over this whole industry,’’ Hunter says. “Their eyes are not on people who are hurt but on the bottom line for the next quarter.’’

The industry’s drive for profit has overwhelmed its obligation to policyholders, says California Lieutenant Governor John Garamendi, a Democrat. As California’s insurance commissioner from 2002 to 2006, Garamendi imposed $18.4 million in fines against carriers for
mistreating customers.

“There’s a fundamental economic conflict between the customer and the company,’’ he says. “That is, the company doesn’t want to pay. The first commandment of insurance is, ‘Thou shalt pay as little and as late as possible.’’’

Although the tension between insurers and their customers has long existed, it was in the 1990s that the industry began systematically looking for ways to increase profits by streamlining claims handling.

Hurricane Hugo was a major catalyst. The 1989 storm, which battered North and South Carolina, left the industry reeling from $4.2 billion in claims.

In September 1992, Allstate Corp., the second-largest U.S. home insurer, sought advice on improved efficiency from McKinsey & Co., a New York-based consulting firm that has advised many of the world’s biggest corporations, according to records in at least six civil court cases. State Farm, based in Bloomington, Illinois, and Los Angeles-based Farmers Group Inc., the third-largest home insurer in the U.S., also hired McKinsey as a consultant, court records show.

When a policyholder files a claim, first make a low offer, McKinsey advised Allstate. If a client accepts the low amount, Allstate should treat the person with good hands, McKinsey said. If the customer protests or hires a lawyer, Allstate should fight back.

One McKinsey slide displayed at the Kentucky hearing featured an alligator with the caption “Sit and Wait.’’ The slide says Allstate can discourage claimants by delaying settlements and stalling court proceedings.

By postponing payments, insurance companies can hold money longer and make more on their investments — and often wear down clients to the point of dropping a challenge. “An alligator sits and waits,’’ Golden told the judge, as they looked at the slide describing a reptile.

McKinsey’s advice helped spark a turnaround in Allstate’s finances. The company’s profit rose 140 percent to $4.99 billion in 2006, up from $2.08 billion in 1996. Allstate lifted its income partly by paying less to its policyholders.

Carriers have also raised premiums and withdrawn from storm-plagued areas such as the Gulf Coast of the U.S. and parts of Long Island, New York — to lower costs and increase income, says Amy Bach, executive director of United Policyholders, a San Francisco-based group that advises consumers on insurance claims.

“What this says is that the industry has been raking in spectacular profits while they’re getting more and more audacious in their tactics,’’ she says.

Claims payouts for the entire property-casualty industry have decreased in the past decade. In 2006, carriers paid out 55 percent of the $435.8 billion in premiums collected, according to the Insurance Information Institute, a trade group in New York.

That compares with a 64 percent payout ratio on $267.6 billion in premium revenue in 1996. As companies pay less to policyholders, their investment gains are growing, according to the trade group and research firm A.M. Best Co. in Oldwick, New Jersey.

Insurance companies are no longer following their mandate to take care of policyholders’ money and then pay it out when needed, says Douglas Heller, executive director of the nonprofit Foundation for Taxpayer and Consumer Rights in Santa Monica, California.

“The whole purpose of insurance is evaporating before our eyes as we continue to send checks to the companies,’’ Heller says. “Insurers are looking to shed their purpose as a risk bearer and become financial institutions.’’

Companies have sharpened the use of technology in the past 20 years to help tighten claims payouts.

Insurers sometimes manipulate these programs to pay out as little as possible, lawsuits have asserted. “Programs like Colossus are designed to systematically underpay policyholders without adequately examining the validity of each individual claim,’’ former Texas insurance commissioner Hunter told the U.S. Senate Committee on Commerce, Science and Transportation on April 11.

“If you don’t accept their offer, which is a low ball, you end up in court,’’ Hunter said. “And that was the recommendation of McKinsey.’’